ECPR Standing Group on Regulatory Governance Biennial Conference

Regulation in an Age of Crisis

Dublin, June 17-19 2010

Governing Irish Companies

Regulation and the Financial Crisis

Replacing 'Comply or Explain' with Legally Binding Corporate Governance Codes: An Appropriate Regulatory Response?

Deirdre Ahern Lecturer in Law

Trinity College Dublin dahern@tcd.ie

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Abstract

At present, like the position in the United Kingdom, compliance with the Financial Reporting Council’s Combined Code on Corporate Governance by companies listed on the Irish Stock Exchange is on the principle of ‘comply or explain’. However, in the midst of a period of economic downturn and financial scandals involving banks, it was considered that there was a need for binding codes of practice to be put in place to ensure high standards of corporate governance. This paper examines whether current proposals for legislatively-backed corporate governance standards constitute an appropriate regulatory response. A legislative approach to key tenets of corporate governance practice involving the mainstreaming of certain core principles as statutory rules may be at the expense of the bespoke tailoring of Ireland’s current corporate governance system which recognises that one size does not fit all. It is suggested that, rather than rushing to legislate, there is a need to conduct a comprehensive public corporate governance policy review in consultation with stakeholders in order to ensure than a suitably effective and durable model is adopted.

I. Introduction The crisis in the US sub-prime market and resulting liquidity squeeze leading to the collapse of venerable institutions such as Lehman Bros in 2008 had worldwide knock-on effects. In Ireland’s case, the collapse of the domestic financial system in an economy which was heavily reliant on the construction sector was attributable to the bursting of the property bubble which had been sustained by an over-supply of credit coupled with a lack of effective oversight by the Financial Regulator as a consequence of ‘light touch’ regulation. The effects on the economy as a whole were devastating and led, first of all to a bank guarantee scheme and later to the setting up of NAMA.1 Given the reach of the financial crisis in Ireland and dire consequences for the economy as a whole, set against the backdrop of the global financial crisis, it is natural that both regulatory systems2 and corporate governance standards should come under the spotlight.3 In times of prosperity where companies are performing well, experience has shown that investors may be disinclined to question corporate governance practices.4 On 1 Pursuant to the National Asset Management Agency Act 2009, NAMA will acquire approximately €81 billion in loans from five participating financial institutions. 2 Significant regulatory failures were exposed, most notably the inaction of the Financial Regulator. On the failings of the Irish Financial Regulator see Editorial, “Where was the Regulator?” (2008) 15(9) Commercial Law Practitioner 214; M. Abramson, “Failures of Financial Regulators in 2008” (2009) 16(3) Commercial Law Practitioner 51; J. FitzGerald, “Fiscal Policy for Recovery” Working Paper No. 326 (ESRI, 2009) http://www.esri.ie/publications/search_for_a_working_pape/search_results/view/?id=2889K. Regling and M. Watson, “A Preliminary Report on The Sources of Ireland’s Banking Crisis” (Prn A10/0700, Government Publications, 2010); P. Honohan, The Irish Banking Crisis – Regulatory and Financial Stability Policy 2003-2008” (2010). 3 See G. Kirkpatrick, The Corporate Governance Lessons from the Financial Crisis (2009, OECD). 4 I. MacNeil and X. Li, “ ‘Comply or Explain’: market discipline and non-compliance with the Combined Code” (2006) 14 Corporate Governance: An International Review 486.

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the other hand, financial crises typically focus attention on corporate governance failures and, by extension, on corporate governance standards. Recent corporate failures exposed in the media revealed poor risk management, non-standard division of leadership responsibilities and ineffective non-executive directors. The wider impact of the financial crisis was recognised in a report on corporate governance commissioned by the Irish Stock Exchange (“ISE”) and the Irish Association of Investment Managers (“IAIM”) which notes that “it appears that the erosion of shareholder value in domestic financial institutions has tainted non-financial ISEQ stocks in the eyes of international investors.”5 This was seen as having an adverse effect on the ability of Irish companies to raise capital in international financial markets. The OECD has also acknowledged that it is important take a wider view on corporate governance than one which is confined to banks.6 The struggle to rebuild the reputation of Ireland both within and outside the financial sector is at stake under the watchful eye of shareholders, stakeholders and financial analysts and the general public who have suffered collateral damage. The financial crisis has therefore given legitimate impetus to the importance of reviewing the appropriateness of corporate governance norms in terms of both content and structure. With the fall-out of the financial crisis in the background, the OECD has acknowledged that “[c]orporate governance policy makers cannot stay aloof from the debate … about the relative role of legally binding, corporate governance requirements and their enforcement as opposed to principles-based flexible instruments.”7 Three indigenous corporate governance reform initiatives which form the backdrop to this paper advocate the imposition of prescriptive corporate governance standards based on legislative intervention in place of continuing to rely on the familiar ‘comply or explain’ regime. The first of these is a private member’s bill – the Corporate Governance (Codes of Practice) Bill 2009 to provide for statutorily-backed corporate governance codes for listed companies. The second is a separate Government commitment to placing the principles of the Combined Code (now the UK Corporate Governance Code)8 on a legislative footing for listed companies, banks and State-sponsored bodies. Parallel proposals from the Financial Regulator are also on the table to provide for legislative corporate governance standards for banks and insurance undertakings. Given the existence of these proposals, together with the commitment of the ISE to commence a review of the Code,9 this is a critical moment in the trajectory of corporate

5 Report on Compliance with the Combined Code on Corporate Governance by Irish Listed Companies (ISE /IAIM 2010) at iii. 6 OECD, Corporate Governance and the Financial Crisis: Key Findings and Main Messages (June 2009) at 12. 7 ibid. 8 Financial Reporting Council (UK), The UK Corporate Governance Code (2010). It applies to financial years beginning on or after 29 June 2010. For the preceding review see Financial Reporting Council (UK), Consultation on the Revised UK Corporate Governance Code (2009); Financial Reporting Council (UK), Review of the Combined Code: Final Report (2009). 9 “Irish Stock Exchange to engage in consultation on Corporate Governance Code for Irish Listed Companies”, Press release of Irish Stock Exchange, 28 May 2010.

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governance progression in this jurisdiction. However, a financial crisis and associated corporate governance scandals give rise to the danger of knee-jerk policy formation by governments which may not be well-crafted for longevity; hastily-composed proposals may in no small part be designed to make political capital out of appeasing public opinion. Accordingly, the issue examined in this paper is the appropriateness of current legislative proposals to move beyond a hybrid ‘comply or explain’ approach to a form of mandatory regulation as a means of shoring up corporate governance and the reputation of ‘Ireland Inc.’. Addressing the question posed requires a preliminary review of how the ‘comply or explain’ approach has fared before probing the relative merits of imposing legislative minimum standards in relation to corporate governance practices. To that end, Part II of this paper gives an overview of the relevant regulatory background in Ireland. Part III evaluates the utility of ‘comply or explain’ as a regulatory approach based on its history to date in Ireland and the UK. Part IV sets out the Irish policy momentum in the direction of mandatory corporate governance reforms. Leading on from that, Part V examines the arguments which may be advanced for and against a mandatory approach to corporate governance norms. Part VI considers whether it is time to go back to the drawing board in order to engage in a comprehensive and co-ordinated review of the Irish corporate governance framework. Part VII concludes that altering the systemic balance of Ireland’s corporate governance framework through the introduction of mandatory norms should not be undertaken lightly without due consideration of the alternatives and their regulatory impact. It will be suggested that quickly devised solutions to corporate governance failings should be put to one side in favour of a more measured review of corporate governance standards in Ireland, in consultation with relevant stakeholders.

II. The Regulatory Background Ireland’s corporate governance framework has been in place for a little more than a decade and applies to a relatively select set of companies although it has been more widely adopted by other companies on a voluntary basis. Ireland is unique in the European Union in not having its own country-specific code of corporate governance. Rather, since 1999 the ISE has adopted the Combined Code on Corporate Governance (now the UK Corporate Governance Code) by means of annexing the Code to its Listing Requirements. In line with this, companies listed on the Main Securities Market (MSM) of the ISE are required to use their annual reports to ‘comply or explain’.10 More recently, the implementation of the Company Reporting Directive11 bolstered the ‘comply or explain’ corporate governance framework by adding a further corporate governance compliance layer in the form of a requirement for companies listed on the MSM to include a corporate governance compliance statement in the directors’ report or as a separate report attached to the balance sheet providing information in relation to the

10 In 2009, 35 companies had shares listed on the Main Market (now known the Main Securities Market or MSM) (other than companies whose primary listing was in a market outside the UK and Ireland): Grant Thornton (Ireland), Corporate Governance Review 2010 (2010) at 7. 11 Directive 2006/47/EC on Company Reporting implemented by the European Communities (Directive 2006/46/EC) Regulations 2009 (S.I. No. 450 of 2009).

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corporate governance code to which the company adheres and the reasons for any departures from it.12 Significantly, there is a certification role for auditors who are required to be satisfied that the corporate governance statement addresses the relevant matters. Obviously it is sensible for companies not to wait to be asked in relation to implementing good corporate governance practices but to be pro-active in this regard.13 The introduction in 2010 of a voluntary benchmark by the Institute of Directors and the National Standards Authority of Ireland in the form of SWIFT 3000: 2010 Code of Practice for Corporate Governance Assessment in Ireland. a Code of Practice for Corporate Governance Assessment in Ireland assists those companies who wish to take governance seriously.

III. Evaluating ‘Comply or Explain’ as a Regulatory Approach Any encroachment on the primacy of the ‘comply or explain’ corporate governance model in Ireland needs to be rooted not just in a response to immediate concerns raised by the collapse of the economy, but also to be based on an understanding of the evolution, durability and efficacy of the current ‘comply or explain’ model. It is pertinent to note the origins of the ‘comply or explain’ model in the UK as a response to corporate governance scandals of the 1980s such as Maxwell Communications pension fraud, Polly Peck’s insolvency and the collapse of the BCCI. The terms of reference of the Cadbury report’s investigation of the corporate governance system were to make recommendations with a view to restoring investor confidence. This led to the introduction of the flexible ‘comply or explain’ approach and the resulting Cadbury Code incorporated in the Listing Rules was a voluntary one rather than being a statutory code. This non-statutory model was founded on the belief that “statutory measures would impose a minimum standard and there would be a greater risk of boards complying with the letter, rather than with the spirit, of their requirements”14 The legitimacy of the Code rested on the well-founded expectation that shareholder pressure would be sufficient to ensure its widespread adoption.15 Subsequent reports did not tinker with ‘comply or explain’. Indeed, the Higgs Report16 and the Smith Report17 were published in 2003 in the wake of the Enron, Worldcom and Tyco scandals and at this point the continuing validity of ‘comply or explain’ was affirmed at a policy level. Most recently, in its 2009 review of the Combined Code, the Financial Reporting Council confirmed that the flexibility offered by a code was preferable to a more prescriptive

12 Companies Act 1963, s.158(6C) (inserted by Regulation 9 of the 2009 Regulations). 13 See H. Siebens, “Concepts and Working Instruments for Corporate Governance” (2002) 39 Journal of Business Ethics 109. 14 Report of the Committee on the Financial Aspects of Corporate Governance (Cadbury Report) (London: Gee & Co., 1992), para. 1.10. 15 ibid. 16 D. Higgs, Review of the role and effectiveness of non-executive directors (Higgs Report) (DTI, 2003). 17 Audit Committees: Combined Code Guidance: A report and proposed guidance by an FRC appointed Group chaired by Sir Robert Smith (Financial Reporting Council, 2003).

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framework18 and this was confirmed in the latest incarnation of the code, the UK Corporate Governance Code. At the heart of the ‘comply or explain’ approach is voluntary compliance with best practice principles but with a mandatory disclosure requirement in the Listing Rules relating to both compliance and justifying any non-compliance. Consequently, the ‘comply or explain’19 approach is generally regarded as a hybrid falling somewhere in the middle ground between a mandatory ‘hard law’20 and a voluntary ‘soft law’ corporate governance system. It has been aptly described as “a uniquely cost-effective framework of quasi-legal controls”.21 The creation of mandatory corporate governance rules with legislative backing would involve a marked departure from the principle-based22 rather than rule-based nature of the Code which affords discretion to companies as to how they choose to comply, in recognition of the fact that one size does not necessarily fit all. As the Hampel Committee put it:

“Good corporate governance is not just a matter of prescribing particular corporate structures and complying with a number of hard and fast rules. There is a need for broad principles. All concerned should then apply these flexibly and with common sense to the varying circumstances of individual companies.”23

Inherent in the Code’s recognition that one size does not fit all is the freedom given to companies to choose not to comply with the Code. The Preamble to the 2010 edition of the Code makes it clear that the Code “is not a rigid set of rules”24 and consequently it is “recognised that an alternative to following a provision may be justified in particular circumstances if good governance can be achieved by other means”.25 It also states that where a board of a company does not comply, it “should aim to illustrate how its actual practices are both consistent with the principle to which the particular provision relates and contribute to good governance.”26 The importance of avoiding a rigid approach to

18 Financial Reporting Council, 2009 Review of the Combined Code: Final Report (2009) at 2. 19 In the Netherlands and South Africa, the terminology of ‘apply or explain’ has been adopted. 20 The non-legally binding nature of the Code was judicially confirmed in Re Astec (BSR) plc [1999] BCC 59, 80 where a claim for unfair prejudice based on non-compliance with the Code was not upheld. Jonathan Parker J. stated: “The Cadbury Code is a voluntary code of practice, it has no legal force.” 21 M. T. Moore, “The End of ‘Comply or Explain’ in UK Corporate Governance?” (2009) 60(1) NILQ 85 at 86. 22 Notably, reviews have led to provisions of the Code being strengthened and along the way the provisions also became more detailed leaving the Code open to being characterised as becoming increasingly more prescriptive in nature. The lack of an explicit hierarchy in the provisions has also been regarded as problematic see M.T. Moore, “ ‘Whispering Sweet Nothings’: The Limitations of Informal Conformance in UK Corporate Governance” (2009) 1 JCLS 95. 23 Hampel Committee, Committee in Corporate Governance (Final Report) (1998), para. 1.11. 24 Financial Reporting Council (UK), The UK Corporate Governance Code (2010), Comply or Explain, p.4, para. 2. 25 ibid, Comply or Explain, p.4, para. 3 . 26 ibid, Comply or Explain, p.4, para. 3.

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either compliance or non-compliance has been recognised in Ireland at policy level in a report jointly commissioned by the ISE and the IAIM: “Mechanistic compliance with the Code by companies is no more desirable than companies not embracing the Code. If companies find complying with one of the Code’s provisions is difficult, they should exercise the right to diverge from the provision while providing a robust, bespoke explanation to shareholders as to why they have reached this view.”27 This flexibility is sometimes overlooked by those who mistakenly view 100 per cent compliance as the target in relation to the Code without regard being had to individual company circumstances and alternative means of achieving relevant objectives. Under the ‘comply or explain’ regime, the penalties for non-compliance are identical to those available for any breach of the Listing Rules – suspension of share trading and delisting. Delisting from the Stock Exchange is unlikely to be undertaken lightly, particularly given the fact that the ‘comply or explain’ approach makes ascertaining the fact of compliance somewhat equivocal.28 Grant Thornton in its annual review of compliance noted that in practice these sanctions are rarely invoked in an Irish context and observed that the sanctions may be considered inappropriate in that rather than protecting shareholders, such sanctions would punish shareholders as well as management.29 However, apart from these formal sanctions, the efficacy of the Code rests on the prospect of shareholders and analysts questioning whether non-compliance is appropriate and making investment and voting decisions based on this assessment.30 That being the case, compliance with the Code and disclosures related thereto is essentially the ‘default position’ for companies listed on the MSM. In view of the existence of legislative proposals to mandate compliance with corporate governance standards, it is interesting that Grant Thornton has catalogued a decrease in the number of companies asserting full compliance with the Code.31 In the 2010 review, 36 per cent of companies claimed full compliance with 64 per cent listed provisions of the Code that they had not complied with. This was against 51 per cent in full compliance and 46 per cent explaining non-compliance with 3 per cent omitting to state whether they were in compliance with the Code in the 2009 review. However, given the varying reasons for non-compliance some of which are valid and some of which may not be, there is a danger in drawing any rapid conclusions from these statistics. Central to the legitimacy of the Code is the ability to make a judgment as to whether the ‘comply or explain’ approach has been satisfactorily dealt with in an individual company’s case. However, there are considerable challenges to assessing compliance 27 Report on Compliance with the Combined Code on Corporate Governance n 5 above at 10. 28 On this see B.R. Cheffins, Company Law: Theory, Structure and Operation (OUP, 1997) at 414. 29 Grant Thornton (Ireland), Corporate Governance Review 2010 at 3. See also Wymeersch’s view that the delisting option is impracticable, leading as it does to collateral damage to individual shareholders: E. Wymeersch, “The Enforcement of Corporate Governance Codes” (2006) 6 JCLS 113 at 131. 30 The effectiveness of the shareholder role is considered below. 31 Corporate Governance Review n 29 above at 11-12.

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under a disclosure-based regime based on a qualitative assessment of explanations furnished. The efficacy of the ‘comply or explain’ approach depends on the quality of the explanation in non-compliance disclosures. The UK Corporate Governance Code states that “[i]n providing an explanation, the company should aim to illustrate how its actual practices are consistent with the principle to which the particular provision relates and contribute to good governance.”32 Nevertheless, the question of what would constitute a satisfactory explanation for a failure to comply with the Combined Code remains an open one.33 Brief, generic and non-specific explanations which undermine the value of a ‘comply or explain’ approach have been identified as problematic both in the UK and Ireland since they militate against any meaningful evaluation of the significance of the departure from the Code. In the UK, Arcot and Bruno’s empirical study of 245 non-financial companies for the period 1998-2004 uncovered a common practice of providing standard and uninformative explanations for non-compliance which they suggest may point up issues relating to monitoring and enforcement.34 It has been suggested that Irish institutional investors would like non-compliance to be explained through use of a “company specific rationale”.35 However, whether they are actively pressing for that in individual cases is less apparent. At any rate, there is Irish empirical evidence to suggest that the quality of disclosures could be improved to make them more meaningful.36 This was reinforced in the ISE/IAIM report’s recommendation that boards of listed companies should consider: “[E]mbrac[i]ng confident and persuasive communications with shareholders and seek to avoid boiler-plate/uninformative descriptions and explanations. The bespoke nature of the Code regime demands disclosures that are also bespoke. There is scope for providing investors with more meaningful and contextual disclosure on how the principles of the Code have been applied and in explanations for divergence from the Code’s provisions.”37 The ISE/IAIM report on corporate governance shows that 19 of the 29 listed companies surveyed have compliance by explanation with 10 complying with no explanation required. The average number of explanations per company was 1.8.38 The report’s analysis of explanations provided in 2008 annual financial statements makes for illuminating reading.39 Of 49 explanations, 22 were classed as an uninformative explanation, 15 as a boiler-plate explanation and 12 as an adequate explanation. The report went on to recommend that companies should move away from boiler-plate

32 Financial Reporting Council (UK), The UK Corporate Governance Code (20010), Comply or Explain, p.4, para. 3. 33 Arcot and Bruno provide a typology of 5 ascending categories of qualitative explanation: S. Arcot and V. Bruno, “In Letter but Not in Spirit, An Analysis of Corporate Governance in the UK” SSRN Working Paper Series last revised 23 June 2006 at 22-23. 34 Arcot and Bruno, n 33 above. See also MacNeil and Li, n. 4 above at 489. 35 Report on Compliance with the Combined Code on Corporate Governance n. 5 above at p.4. 36 Report on Compliance with the Combined Code on Corporate Governance n. 5 above at 1.3 and 1.4. 37 ibid. at 4. 38 ibid. at 11, Table 1. 39 ibid. at 13, Table 2.

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language40 in favour of explanations which reflect the contextual environment in which the company is operating and a robust justification for non-compliance being in the best interests of the company should be provided.41 The Preface to the UK Corporate Governance Code 2010 suggests that “the fungus of ‘boiler-plate’” might be tackled by chairmen reporting personally in their annual statement on compliance with the Code.42 The linchpin of the ‘comply or explain’ mechanism is the expectation that investors will use the disclosures in relation to non-compliance to question whether instances of non-compliance are justified. However, the relative apathy of institutional investors is notorious. While the market (largely represented by institutional investors) may not have been insisting on compliance in the good times,43 arguably the financial crisis has changed that for the better. As Arcot and Bruno observe, “intervention by shareholders in matters of corporate governance is usually not preemptive, but typically occurs after bad performance.”44 This calls into question the efficacy of relying on a largely self-regulatory model in Ireland and the UK. It can be concluded that while the flexibility of ‘comply or explain’ approach is well-entrenched and emulated internationally, its legitimacy is called into question by non-compliance which is not adequately explained in disclosures and by the passivity of shareholders including institutional investors and intermediaries. These perceived shortcomings have been thrown into sharp relief in the economic turmoil of recent years. The next Part of this paper focuses on the rationale behind Irish legislative proposals to give statutory-backing to corporate governance norms.

IV. The Irish Momentum Towards Mandatory Corporate Governance Norms The financial crisis in Ireland highlighted departures from principles of good corporate governance both within and outside the financial sector. Irresponsible attitudes to risk-taking were exposed as being based on a short term perspective which sacrificed long term interests for short term gains. Apart from bloated remuneration packages, other issues of particular concern which were highlighted were the question of the independence of non-executive directors in the context of their crucial oversight role and departures from best practice in relation to board balance and division of leadership responsibilities. The lack of independent strength on boards with the ability to challenge management on issues such as risk-taking was of particular concern. Worryingly, Grant Thornton’s 2010 corporate governance review noted that a significant minority of companies provided an inadequate explanation for their conclusion that directors were independent who did not meet the Code’s independence criteria.45

40 Boiler-plate has been excoriated in a corporate governance context as “dead communication”: Financial Reporting Council (UK), Consultation on the Revised UK Corporate Governance Code (2009), Chairman’s Preface at para.7 41 Report on Compliance with the Combined Code on Corporate Governance n. 5 above at 14. 42 Financial Reporting Council, UK Corporate Governance Code (2010), Preface, para. 7. 43 On the role of shareholders see OECD, n. 6 above at 48-54. 44 Arcot and Bruno, n. 33 above at 33. 45 Corporate Governance Review 2010 n. 10 above at 14.

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A series of discrediting domestic banking scandals emerged in which dubious practices were highlighted including a hidden loans to directors controversy involving Anglo Irish Bank which became the subject of a regulatory investigation by the Director of Corporate Enforcement. Other individual instances of ill-advised departures from corporate governance best practices received media attention such as former CEO Sean Fitzpatrick assuming the role of a chairman of Anglo-Irish Bank which was compounded by a failure to appoint an independent deputy chairman as promised. AIB also fell foul of best practice when it announced that its non-executive chairman Dan O’Connor would act as its executive chairman on an interim basis while it searched for an external candidate to fill the role. Furthermore, the media focus on the phenomenon of ‘crony capitalism’ concerning reciprocal cross-directorships between companies, particularly banks, had particular resonance in a small nation such as Ireland.46 Against the backdrop of extensive media attention in relation to such corporate governance practices, a number of different tentative legislative proposals concerning corporate governance norms have resulted which implicitly call into question the continuing utility of relying on a ‘comply or explain’ model whose enforcement is largely dependent on the inclination of a largely passive shareholder body. The Corporate Governance (Codes of Practice) Bill 200947 was introduced as a private member’s bill in the Dáil by Opposition Labour leader Eamon Gilmore on 23 April 2009. However, the Bill has not had a second stage reading and realistically may be superseded by Government proposals in this sphere. The Explanatory Memorandum to the Bill refers to the “serious reputational damage” suffered by Irish business and regulators and states that “it has become clear that voluntary codes are no longer adequate to provide assurance to investors and others as to the maintenance of the necessary high standards of good corporate practice.” The Bill was therefore designed to enable the Financial Regulator in its capacity as regulator of the ISE to draft corporate governance codes which would be binding on companies admitted to trading on the official list and enforced by the ISE as part of the Listing Rules.48 Notably, rather than being founded on a shareholder protection platform which is the traditional preserve of corporate governance, section 6(1) of the Bill envisages that in drafting the code the interests of customers and the general public be borne in mind as well as the objective of promoting fair competition in financial markets in the State. Section 6(2) sets out some prescriptive content for any code of practice drawn up. Some of this echoes familiar corporate governance concepts such as a prohibition on the positions of chairman and chief executive being held by the same person and a

46 The issue of interlocking boards has been mapped and it has been shown that a small pool of individuals dominate boards in Irish listed companies and state-owned bodies. See further P. Clancy, N. O’Connor and K. Dillon, Mapping the Golden Circle (Tasc, Dublin, 2010) at para. 6.12. 47 Long title: “an Act to provide for the drawing up by the Central Bank and Financial Services Authority of Ireland and the approval by the Minister for Finance of codes of practice in relation to good corporate governance for companies admitted to trading on the official list of the Irish Stock Exchange; to provide for the enforcement of those codes; and to provide for connected matters”. http://www.oireachtas.ie/documents/bills28/bills/2009/2209/b2209d.pdf. 48 The Bill envisaged that different codes of practice could be drawn up for different-sized companies, measured by market capitalisation.

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prohibition on a former chief executive of the company being elected as its chairman. The Bill proposes providing for a prohibition on non-executive directors serving on a board for more than seven consecutive years;49 and a limit on the number of boards of listed companies on which a non-executive director may sit. Of particular interest is the proposed prohibition on reciprocal cross-directorships and the regulation of appointments of non-executive directors who are connected to the company’s bank or auditors.50 The second proposed initiative emanates from the Government in the form of some loosely sketched plans for corporate governance reforms. Its Renewed Programme for Government of 10 October 2009 contains a commitment to place certain principles from the Combined Code on a legislative footing for all banks, public companies and state-sponsored bodies.51 This commitment is to deal with a range of matters including board composition and independence, segregation of CEO and chair functions, defining executive and non-executive responsibilities, selection of non-executive directors, composition and role of audit committees and board committees. At this stage it is unclear to what extent the content of the proposed mandatory norms will differ from that which is already in place for listed companies under ‘comply or explain’ and whether transposition to a legislative setting will lead to a more prescriptive set of rules. It is intended to provide for sanctions for compliance although at this point no indication has been given as to what these might be. To date no concrete proposals have materialised in relation to this legislative commitment. That being the case, and given the brief manner in which these legislative proposals were dealt with in the Renewed Programme for Government, it is not possible to engage with them other than at a macro level. The most concrete set of proposals for movement in the direction of mandatory norms in Ireland is also the most recent. In May 2010 the Financial Regulator began a consultation in relation to the development of new statutory corporate governance rules for major financial institutions dealing with matters such as board composition, independence, board committees, and division of leadership responsibilities.52 It is proposed that relevant institutions will have to submit an annual compliance statement to the Financial Regulator specifying whether they have complied with the relevant requirements. Notably, the Financial Regulator has indicated that the effect of legislating in this sphere would be to make non-compliance subject to either administrative sanctions by the Financial Regulator or to criminal sanctions. The administrative sanctions procedure

49 This goes beyond the requirement of “rigorous review” for terms beyond six years in provision B.2.3. of The UK Corporate Governance Code (2010) and the indication in provision B.1.1. that a non-executive director who has served for more than nine years may not be regarded as independent. 50 At present cross-directorships and links with other directors are treated as a prima facie indicator that a non-executive director may not be independent: Financial Reporting Council (UK), The UK Corporate Governance Code (2010), Provision B.1.1. 51http://www.taoiseach.gov.ie/eng/Publications/Publications_2009/Renewed_Programme_for_Government,_October_2009.pdf. 52 Central Bank & Financial Services Authority of Ireland, Consultation Paper CP41: Corporate Governance Requirements for Credit Institutions and Insurance Undertakings (2010) available at http://www.financialregulator.ie/consultation-papers/Documents/CP41%20-%20Corporate%20Governance%20Requirements/Corporate%20Gov%20Requirements.pdf.

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offers a certain amount of flexibility including the possibility of reaching a binding settlement to resolve the matter. This mandatory approach to corporate governance of financial institutions is no doubt in part designed to respond to criticisms concerning what was seen to be ‘light touch’ regulation on the part of the Financial Regulator in relation to risk-management in financial institutions. It can be contended that given the central importance of banks in the economy, they should be treated differently and that therefore mandatory norms are appropriate. That being said, it is worth noting that the proposed legislative approach is out of step with trends in the UK based on the stance taken in the Walker Report53 which is to affirm the value of continuing with a ‘comply or explain’ approach. However, the issue of specifically legislating for corporate governance norms in the financial sector remains an open one at EU level and is subject to an ongoing consultation process.54 At this germinative stage, it is too early to make a substantive assessment of the likely impact of the various proposals for enshrining aspects of corporate governance standards in statute in Ireland as regards their content, enforcement and fit and as to the role of the various agencies. It may be that Ireland is moving towards a two tier hierarchial corporate governance system where some norms are absolute mandatory rules and others are default standards. Given that there is an appetite for moving to mandatory norms, it is useful to evaluate the arguments which may be advanced in relation to the desirability of incorporating elements of a mandatory approach to corporate governance into a system which up until now can be described as being “partially enabling or hybrid”.55 It is appropriate that this debate be commenced given the significant regulatory and compliance implications of moving to a mandatory approach. Failure to take appropriate soundings from stakeholders and other interested parties before proceeding may lead to problems further down the line.

V. Evaluating a Mandatory Approach From the point of view of reputation, legislative standards send an international signal that corporate governance standards are taken seriously. On the other hand, regulatory arbitrage is an issue and an appropriate balance needs to be struck so that companies are not dissuaded from listing on the MSM based on a perception of there being an unduly restrictive compliance burden. The objective of ensuring good corporate practices and restoring reputation must therefore be balanced against the risk that if the resulting

53 See D. Walker, A Review of Corporate Governance in UK Banks and other Financial Industry Entities (HM Treasury, 2009). 54 The EU has recognised the need to give separate consideration to corporate governance mechanisms in the financial sector. It has been contended that “[g]iven the particular role they play in the economy and potential impact of their activities on financial stability, corporate governance in financial institutions present specific features which differentiate them from listed companies in general.”: “European Commission Green Paper on corporate governance in financial institutions and report on remunerations – frequently asked questions” Europa Press Release Memo/10/2009 2 June 2010; European Commission, Corporate Governance in Financial Institutions and Remuneration Policies COM (2010 284 final). 55 A.I. Anand, “An Analysis of Enabling vs. Mandatory Corporate Governance: Structures Post-Sarbanes-Oxley” (2006) 31 Del. J. Corp. L. 229 at 246.

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scheme is judged to be unduly harsh by comparative standards, this may adversely affect listings on the MSM. Consequently, caution is advised before proceeding down a legislative route. While not unknown, a mandatory approach to corporate governance represents the exception rather than the norm in the common law world. The notable exception is the controversial Sarbanes-Oxley Act56 which made some aspects of corporate governance compliance mandatory with legal sanctions for non-compliance.57 The Sarbanes-Oxley approach of going beyond requiring a majority of independent directors on a board to requiring audit, nomination and compensation committee to comprise only independent directors has been criticised.58 It has also resulted in a huge cost of compliance which has proved a disincentive to some foreign firms listing in US capital markets. Other common law jurisdictions such as the UK, Canada, Australia and South Africa have not gone down the mandatory route but have preferred what have been termed “partially mandatory structures”59 based on the ‘comply or explain’ concept of disclosure. This approach has also been affirmed as appropriate at a pan-European level in the Company Reporting Directive. This suggests that a mandatory approach to corporate governance enshrined in legislation would leave Ireland somewhat out on a limb. Examining The Case for a Mandatory Model As noted above, mandatory corporate governance norms can be seen as a way of signalling to the market that the concerns of investors are taken seriously, thereby helping to rebuild investor confidence. Therefore it can be maintained that the imposition of legislatively-backed corporate governance standards is an appropriate response to negative externalities imposed by the fall-out of the financial crisis.60 On its face this proposition is attractive as the Irish economy lies crippled and hindsight judges harshly directors who failed to exercise appropriate control. In reality, the suitability of a legislative response needs to be tested on the basis of a reflective approach to both legislative solutions and available alternatives. A willingness to announce legislative proposals may be a face-saving measure by governments and regulators who are keen to be doing something and therefore may not be prepared to give appropriate pause for thought in relation to whether this is the correct route and, if so, how can a mandatory system best be constructed. Consequently, the exploration of a mandatory or partially mandatory approach needs to be done on a considered basis. In other words, legislative embedding of corporate governance norms may legitimately be considered in an age of crisis but this is on the assumption that alternatives are also weighed in the balance.

56 The Public Company Accounting Reform and Investor Protector Act of 2002 Public Law 107—204, 116 Stat. 745. 57 This is sometimes dubbed ‘comply or else’. 58 See A. Barden, “US Corporate Law Reform Post-Enron: A Significant Imposition on Private Ordering of Corporate Governance?” (2005) 5 J. Corp. L. Stud. 167 at 172-174; L.E. Ribstein, “Market versus Regulatory Responses to Corporate Fraud: A Critique of the Sarbanes-Oxley Act of 2002” (2002-2003) 28 Journal of Corporation Law 1. 59 J. Zadkovich, “Mandatory Requirements, Voluntary Rules and ‘Please Explain’: A Corporate Governance Quagmire” (2007) 12 Deakin L. Rev. 23 at 24. 60 ibid at 38.

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Moving to examine the weaknesses of the Code, unquestionably one of the difficulties with the self-regulatory model is that there is a certain conflict of interest involved in allowing the board of directors to be the decision-making body in relation to compliance with or departure from the Code. This can result in self-interested decision-making which does not serve the interests of shareholders or other stakeholders. This is so notwithstanding the independent equitable duty on directors to act in the best interests of the company. By contrast, mandatory norms afford the opportunity of imposing uniform standards through the mechanism of a statutory duty of compliance. Consequently, perhaps the key advantage of incorporating a mandatory approach which does not afford companies discretion as to compliance and is linked to penalties for non-compliance is the likelihood of securing direct compliance through deterrence thereby achieving investor protection and public confidence objectives.61 More than anything a mandatory approach may appear appropriate on the basis of a conclusion that the market has failed in its anticipated monitoring role. The Financial Reporting Council has noted that companies and shareholders share the responsibility for ensuring that ‘comply or explain’ continues to be “an effective alternative to a rules-based system.”62 Thus Dallas and Scott have argued that if the market is not willing to ask questions if credible explanations are not provided, this may set the stage for moving in the direction of tighter regulation.63 The coercive effect of a statutory duty of compliance is undeniable and would rule out the need to rely on the indirect carrot and stick approach bases on the need to appease investor sentiment, an approach which has proved demonstrably faulty where individual and institutional investors are apathetic. In an Irish context it is legitimate to ask whether the corporate governance role which was envisaged for the ISE, institutional investors and the IAIM has been delivered in reality and, if not, whether it is time to move towards formal regulatory structures.64 Both the separation of ownership and control and the proliferation of institutional investors mean that investors are notoriously passive and are often driven by corporate performance measures above the minutiae of corporate governance. This is consistent with international studies which suggest that institutional investor focus on corporate governance compliance is inversely linked to financial performance.65 Recently, there has been an upsurge in institutional clients of investment firms seeking evidence that corporate governance issues are being engaged with.66 It can be said in the abstract that a properly structured mandatory rule-based approach could conceivably facilitate greater teeth being given in the forms of sanctions and enforcement. This would appear to be a motivating factor in relation to both the

61 ibid at 31. 62 Financial Reporting Council (UK), The UK Corporate Governance Code (2010), preamble, para. 6. 63 G.S. Dallas and Hal S. Scott, “Can One Set of Rules Fit All? Mandating Corporate Behavior” (2006) 2 Corp. Governance L. Rev. 117 at 143. 64 Grant Thornton has led the charge in an analysing compliance trends and only later did the ISE together with the IAIM commission an independent report on compliance. 65 MacNeil and Li, n. 4 above. 66 Report on Compliance with the Combined Code on Corporate Governance n. 5 above at 29.

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Government’s and the Financial Regulator’s legislative proposals. Indeed, on one view mandatory rules may result in a level of compliance which goes beyond formulaic compliance given the possibility of actual penalties resulting and a regulator being tasked with an enforcement function provided that enforcement appears credible. The meaningfulness of a mandatory approach needs to be appraised in relation to the appropriateness of the sanctions and the credibility associated with enforcement mechanisms and resources. This can only be assessed once legislative proposals have matured. What can be said in relation to the status quo is that currently neither the ISE nor the IAIM has a strong market reputation in relation to enforcement of the Code. Tasc, an Irish independent think tank has branded ‘comply or explain’ a “failed concept of self-regulation”.67 Without a doubt, over-reliance on institutional investors to act as watchdogs has been exposed as inadequate as decision-making may be more likely to be swayed by financial returns than corporate governance benchmarks. In this regard, Lord Myners aptly suggested that investors often acted as “absentee landlords”.68 It has been suggested that institutional investors in Ireland have not favoured a “statute or rules based governance regime”.69 However, at the same time they have not been particularly vocal in relation to high-profile deviations from corporate governance norms.70 Costs are an issue in relation to the introduction of mandatory norms. There is the question of whether a mandatory or partially mandatory regime would yield cost savings for issuers.71 This depends on the certainty which is attached to those norms in relation to interpreting what is required in order to achieve compliance. Moore contends that a one size fits all approach may result in unnecessary costs to companies for installing an inappropriate corporate governance structure.72 Under a rule-based approach issues of scope and wording are likely to focused on. Certainly, the potential for costs savings in a regime involving the introduction of mandatory norms may be less obvious in relation to a hybrid corporate governance system involving parallel and possibly overlapping mandatory and disclosure-based standards. The regulatory costs of monitoring compliance with mandatory norms are likely to be higher than in a disclosure-based regime. There are significant costs associated with implementing a mandatory system of corporate governance, particularly once which is to be properly policed. It may, however, be regarded as cost-effective for investors.73 It is plausible that investors would expend less time on questioning compliance with mandatory norms in the form of statutory rules than under a ‘comply or explain’ approach, depending on the specificity with which those mandatory norms are expressed. If a clear enforcement role is given to a regulator and the regulator is seen by the market to be adequately fulfilling that role, investors are less

67 Clancy, O’Connor and Dillon, n. 46 above at para. 6.10. 68 Speech by Lord Myners on 21 April 2009 at Association of Investment Companies conference, para. 38. See http://webarchive.nationalarchives.gov.uk/+/http://www.hm-treasury.gov.uk/speech_fsst_210409.htm 69 Report on Compliance with the Combined Code on Corporate Governance, n. 5 above at 6.3. 70 However, in 2008 IAIM successfully pressed for the resignation of Jim Flavin as Executive Chairman of DCC plc following the Supreme Court’s finding that he had engaged in insider dealing. 71 R. Romano, “Answering the Wrong Question: The Tenuous Case for Mandatory Corporate Laws” (1989) Colum. L. Rev. 1599 at 1603. 72 Moore, n. 21 above at 100. 73 Zadkovich, n. 59 above at 33.

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likely to independently assess compliance. That being said, the market may require corporate governance standards which go beyond either those prescribed by law or under a ‘comply or explain’ code. Therefore there is potential for time and energy expended on dialogue in relation to such matters. The Case Against A Mandatory Model The primary arguments which can be marshalled against mandatory corporate governance norms are largely focused on the benefits of the flexibility afforded to companies by ‘comply or explain’ codes. In this respect, it is instructive to recall the words of Sir Derek Higgs who contended that a ‘comply or explain’ approach “offers flexibility and intelligent discretion and allows for valid exception to the sound rule.” 74 By contrast, his view was that “[t]he brittleness and rigidity of legislation cannot dictate the behaviour, or foster the trust ... that is fundamental to the effective unitary board and to superior corporate performance.”75 This concern goes to the heart of the spirit which imbues adherence to principles rather than rules, the collective ‘buy-in’ by companies which characterises ‘comply or explain’ is likely to be lost once these principles become statutory rules which apply by operation of law with no room for finesse or fine-tuning by subjects who were previously active participants moulding the corporate governance framework to meet their company’s needs where appropriate. This may trigger blind adherence rather than an overall enhancement of the corporate governance culture. The essence of responsible practices can be lost in attempting to legislate for matters which have previously been in the realm of business ethics.76 That being the case, compliance may be more formalistic and in the nature of a ‘box ticking’ exercise in the case of a legislative requirement. A dominant concern in relation to providing for mandatory norms is that a ‘one size fits all’ model may be too prescriptive and may ride roughshod over alternatives which are perfectly adequate to meet the twin needs of business and investor protection.77 This factor was influential in South Africa opting not to pursue a statutory route in its latest King III Code of Governance.78 The flexibility of ‘comply or explain’ recognises that it may be appropriate for good governance practices to be achieved in another way.79 Indeed, on the question of flexibility, many would argue that companies are not homogenous entities and therefore different corporate governance structures are appropriate as is recognised under the Code.80

74 D. Higgs, n. 16 above at 3. 75 ibid. 76 S. Arjoon, “Striking a Balance Between Rules and Principles-based Approaches for Effective Governance: A Risks-based Approach” (2006) 68 Journal of Business Ethics 53. 77 ibid at 57. 78 Institute of Directors of Southern Africa, King Code of Governance for South Africa 2009 (2009) at 5. 79 See Financial Reporting Council, Review of the Effectiveness of the Combined Code: Progress Report and Second Consultation (2009) at 25. 80 Arcot and Bruno, n. 33 above; S.R. Arcot and V.G. Bruno “One Size does Not Fit All, After All: Evidence from Corporate Governance” last revised 15 January 2007 http://ssrn.com/abstract=887947; MacNeil and Li, n. 4 above at 486.

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Attempting to shift norms from a principle-based setting to a mandatory setting is fraught with difficulty given the prescriptiveness associated with rules. Some familiar principles can certainly be easily provided for such as a prohibition on a chief executive becoming a chairman. However, other principles couched in general terms in the Code may not readily be transposed to a legislative setting. Realistically, matters such as board expertise, appropriate oversight and risk management do not readily lend themselves to legislative prescription. If it is attempted to translate broad principles into rigid rules this gives rise to the possibility of overly-restrictive rules being put in place or to the possibility of general wording being employed which gives rise to uncertainty as to how the provision may be applied in a given case. This is likely to increase the compliance burden through the need to obtain legal advice. A real concern with legislative intervention is that if not well-executed and in line with market demands, its relative permanence may jar. In the UK, based on public consultation, the Financial Reporting Council recently affirmed the flexibility associated with ‘comply or explain’ as permitting the standards adopted to be both more demanding and more easily adaptable to take account of best practice developments.81 By contrast, a danger with a prescriptive mandatory approach is that if mandatory norms are directly enshrined in primary legislation, they would only be capable of being amended by primary legislation and this regulatory approach would therefore less responsive to market needs. As Barden has observed, if best practice rules are enacted as mandatory rules they are viewed as “substantially harder to deviate from, unless legislators are unusually responsive.”82 Without a doubt, the financial crisis has exposed an enforcement deficit, most notably in relation to the active questioning of Code departures was not entrenched at institutional shareholder level. The failure of investors to adopt a robust questioning approach to corporate governance has been one of the big stories of recent times. However, rather than deciding that the existing form of regulation is unworkable, there needs to be a consideration of whether shareholder engagement can be addressed through rethinking the principles to which institutional investors are expected to adhere. Perhaps the most cogent argument that can be marshalled against a snap decision to opt for a mandatory model is that calls for legislation are putting the cart before the horse in relation to how the corporate governance agenda might best be achieved in Ireland. Corporate governance standards may indeed need tightening but an alternative view is that the crux is ensuring appropriate corporate buy-in, a task which is aided by a corporate governance culture, adherence with directors’ duties and appropriate questioning of corporate governance practices based on the oversight roles of non-executive directors and institutional investors.83 There is a danger that a careful, holistic

81 See Financial Reporting Council, Review of the Effectiveness of the Combined Code: Progress Report and Second Consultation (2009) at 25. 82 Barden, n. 58 above at 175. 83 The Walker Review, n. 53 above, highlighted the need to review the role of institutional investors based on the adoption of principles of stewardship. This led to the Financial Reporting Council’s Consultation on a Stewardship Code for Institutional Investors (2010).

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examination of corporate governance mechanisms may be jettisoned in favour of a willingness to dismiss ‘comply or explain’ without thought to whether it needs re-focusing. As such, there is a danger of throwing the baby out with the bathwater. This argument is developed below.

VI. Time to Go Back to the Drawing Board? While some putative arguments in favour and against the introduction of mandatory corporate governance norms have been considered, the purpose of this paper has not been to reach a definitive position as to whether mandatory corporate governance norms are preferable to a ‘comply or explain’ approach. Such an assessment is militated against at a as the underlying policy has yet to be fully developed in relation to the disparate legislative measures under consideration in Ireland. However, given that the legislative proposals outlined in this paper are at an early stage of development, there is potential for a more thorough investigation of the terrain before proceeding to a defined policy position which cannot be easily resiled from. As has occurred in other jurisdictions, a full debate on appropriate regulatory responses to corporate governance with participation from relevant stakeholders would be beneficial and would help to guard against revisionism based on unco-ordinated legislative efforts conceived in haste, the implications of which have not been fully thought through. As was noted in relation to Sarbanes-Oxley, “haste makes waste.”84 A rush to legislate may be too simplistic an approach to solving the reputational damage of the financial crisis and may be unfairly harsh in its judgment of the legacy of the ‘comply or explain’ approach. Zingales observes the cyclical nature of calls for regulation in recessionary times. He contends that where calls for regulation are linked to current problems in a recession rather than to times of economic prosperity, this typically involves an overweighting being given to ex post considerations and an underweighting to ex ante arguments.85 This can distort the projected assessment of the ability of the selected regulatory mechanism to deliver the desired objectives. Policy-makers in Ireland would therefore do well to note the OECD’s emphasis on the importance of carrying out a regulatory impact assessment before rushing down the legislative path. The OECD notes that “[i]n the rush to new legislation that might be underpinned by the imperative ‘not to waste a crisis’ there might be a tendency to not clearly specify the problem and whether the proposed legislation can address it in a cost effective manner.”86 In South Africa where extensive consideration preceded the issue of King III in 2009, it was noted that “[p]opulist calls for more general legislative corporate governance reform must be treated with the appropriate caution.”87

84 M.A. Perino, “Enron’s Legislative Aftermath: Some Reflections on the Deterrence Aspects of the Sarbanes-Oxley Act of 2002” Columbia Law School Working Paper No. 212 (October 2002) http://ssrn.com/abstract=350540 at 2. 85 L. Zingales, “The Future of Securities Regulation” (2009) 47 Journal of Accounting Research 391 at 400. 86 OECD Steering Group on Corporate Governance, Corporate Governance and the Financial Crisis: Conclusions and emerging good practices to enhance implementation of the Principles (2010) at para. 15. 87 Institute of Directors of Southern Africa, King Code of Governance for South Africa 2009 (2009) at 8.

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An additional policy development shortly to be spearheaded by the ISE underlines the importance of a joined up approach to regulatory policy. The Chairman of the Stock Exchange has acknowledged that “[w]e need to have an open and balanced discussion that is focused on making sure our governance arrangements are fit for purpose.”88 Subsequently, on the day that the Financial Reporting Council announced the latest UK Corporate Governance Code, the ISE announced its intention to commence a consultation process on the implementation of a revised corporate governance code for Irish listed companies.89 A review of the operation of the ‘comply or explain’ approach in Ireland should include consideration of the need for a specific Irish corporate governance code rather than simply appropriating the UK Corporate Governance Code to an Irish context. Part of the equation in any policy review relates to consideration of the need for a country-specific corporate governance framework which is tailored to the needs of the Irish commercial landscape. This has been highlighted by the recent re-naming of the Combined Code in its latest incarnation as the UK Corporate Governance Code. It is important that the disparate policy developments discussed in this paper do not continue their gestation in isolation from one another. Consequently, it is now high time for an independent comprehensive review to be undertaken of corporate governance requirements with a view to establishing a model of corporate governance regulation which best suits Ireland’s needs. The limitations of any corporate governance framework should also be borne in mind. At the end of the day, as the FRC recognised in its recent review of the Combined Code, “the quality of corporate governance ultimately depends on behaviour not process, with the result that there is a limit to the extent to which any regulatory framework can deliver good governance.”90 In this context corporate governance is best looked at as being supported by a number of different media including the common law and equitable duties of directors as well as market expectations.91 Furthermore, it is worth taking into account that, in line with international trends, it is intended to place directors’ equitable and common law duties on a statutory footing. Any policy consideration of the benefits of using a mandatory approach will have to consider the overall impact of implementing mandatory corporate governance norms and the appropriate blend of mandatory and non-mandatory regulation. If mandatory norms were to operate in parallel with a ‘comply or explain’ code, this would lead to a hybrid partially enabling / mandatory model which could be rather cumbersome for companies to comply with. Structurally, this may be a rather inelegant solution. As a consequence, companies might be inclined to favour an overall ‘tick the box approach’ rather than meaningfully engaging with the implications of both formal legal requirements and their interaction with the flexibility of soft law ‘comply or explain’ requirements. Therefore a holistic approach to corporate governance policy formation is needed. Arjoon has argued against excessive reliance on a rules-based approach which increases the cost of doing 88 See “High governance standards and transparency now needed” The Irish Times April 30, 2009. 89 “Irish Stock Exchange to engage in consultation on Corporate Governance Code for Irish Listed Companies”, Press release of Irish Stock Exchange, 28 May 2010. 90 Financial Reporting Council, 2009 Review of the Combined Code: Final Report (2009) at para. 2.1. 91 In a UK context see J. Armour, “Enforcement Strategies in UK Corporate Governance: A Roadmap and Empirical Assessment” in J. Armour and J. Payne (eds) Rationality in Company Law: Essays in Honour of DD Prentice (Hart Publishing, Oxford, 2009).

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business and may overshadow essential aspects of good corporate governance.92 She argues that such an approach may “create a culture of dependency and can result in legal absolutism.”93 It is therefore important to seek an optimal balance between the consistency of a rules-based approach and the flexibility of a principles-based approach. The Irish business environment has its own unique features and challenges. For example, one of the corporate governance challenges in Ireland is the remarkably small pool of persons sitting on the boards of listed companies in Ireland.94 Therefore any policy consideration of a mandatory model for embedding corporate governance norms should be based on a balanced evaluation of alternatives within the distinct factual context of Irish listed companies and relevant corporate governance patterns. At the same time, any review in this area should also take into account relevant corporate governance policy choices in other common law countries, at EU level and the work of the OECD in this area which indicates a broad preference for a ‘comply or explain’ approach.95 The continuing potential of ‘comply or explain’ should not be too readily dismissed. As the preface to the UK Corporate Governance Code notes, there is “scope for an increase in trust which could generate a virtuous upward spiral in attitudes to the Code and its constructive use.”96 As in other countries, one of the key issues for consideration in any review of corporate governance standards is the question of whether it is possible to enhance the efficacy of ‘comply or explain’ by promoting effective shareholder engagement. Shareholder engagement has been championed in the UK on the basis that shareholders such act as stewards of companies including banks. If institutional investors are willing to take a more pro-active stance to questioning company practices,97 this may remove some of the force from the case for a mandatory argument approach. This issue is under consideration by the Financial Reporting Council and the issue of shareholder responsibility will shortly move to EU policy level.98 Therefore, it is perhaps too early to write off institutional shareholders and intermediaries as being incapable of fulfilling a watchdog role. It is important that a policy focus on the form of corporate governance norms does not occur at the expense of a consideration of complex enforcement questions.99 At a time when the premise of a ‘soft’ disclosure-based regulatory approach has been called into question, there is a need for a more co-ordinated approach to be taken by relevant 92 Arjoon, n. 76 above. 93 ibid at 53. 94 See n. 88 above. 95 The OECD did not favour a regulatory approach over a code-based approach given the complexity of corporate governance: OECD Steering Group on Corporate Governance, n. 86 above at para. 3. 96 Financial Reporting Council, The Corporate Governance Code (2010), Preface, p.5, para. 6. 97 See T.G. Lynn, “Encouraging Irish Pension Funds to Act as Shareowners – Suggested Statutory Reform” (2006) 13(10) Commercial Law Practitioner 240. 98 European Commission, Corporate Governance in Financial Institutions and Remuneration Policies COM (2010 284 final) at 3 and 16-17. 99 The OECD has emphasised the need for member jurisdictions to engage in a regular review of enforcement agencies to ensure that they are properly resourced and empowered to deal with corporate governance deficiencies: OECD Steering Group on Corporate Governance, n. 86 above at para. 14.

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agencies such as the ISE, the Financial Regulator and relevant Government departments such as the Department of Enterprise, Trade and Employment and the Department of Finance. Regulatory overlap may lead to inconsistencies of approach and make compliance more difficult and more costly. The OECD has emphasised the importance of regulatory authorities in delivering a sound corporate governance framework and the OECD Principles recommend that “the division of responsibilities among different authorities in a jurisdiction should be clearly articulated and ensure that the public interest is served.”100 In order for the appropriate certainty, legitimacy and efficacy to be afforded to corporate governance standards, attention needs to be focused on the interface between the respective roles of the Government, the ISE and the Financial Regulator in relation to corporate governance policy. The ISE (which is regulated by the Financial Regulator) has the dual role of market operator in relation to listed markets as well as regulator and has a focus on corporate governance compliance through its role in enforcing the Listing Rules. This interface has been highlighted by recent parallel corporate governance policy initiatives. Traditionally, it has been recognised that different objectives are at work in relation to corporate governance standards and prudential supervision. The traditional view is that corporate governance standards are concerned with the protection of shareholders101 while prudential supervision is concerned with the protection of the public as the consumer. Thus corporate governance has been identified as being concerned with the private costs to shareholders with prudential regulation being concerned with the social costs of risk-taking by financial institutions.102 Thus “[t]he main objective of codes of governance is to limit agency problems between shareholders and management and amongst shareholders ….”103 Prudential supervision is therefore concerned with the stability of and public confidence in the financial system. However, in the fall-out from the banking crisis, it is increasingly maintained that it is no longer sufficient for governance systems to focus solely on protection of shareholders given the impact on the lives of ordinary citizens.104 Indeed, in recent times given the impact on citizens, there has been a tendency towards combining these objectives and this is seen in recent corporate governance initiatives in Ireland.

VII. Conclusion The adverse effect of the financial crisis on corporate performance across all sectors has reinvigorated the relevance of corporate governance objectives and highlighted a public interest agenda. Against the backdrop of the financial crisis, a number of overlapping proposals exist which are designed to recalibrate the regulatory balance in Ireland’s corporate governance system by introducing mandatory content with legislative backing. Giving corporate governance standards regulatory teeth in the form of mandating

100 OECD, OECD Principles of Corporate Governance (2004), Principle I.C. 101 See Walker Review n. 53 above at 1.1. 102 See K. Alexander, “Bank Resolution Regimes: Balancing Prudential Regulation and Shareholder Rights” (2009) 1 JCLS 61, 64. 103 Arcot and Bruno, n. 33 above at 27. 104 Clancy, O’Connor and Dillon, n. 46 above at para. 6.11.

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compliance with certain aspects may satisfy the need to be seen to be acting in order to restore the reputation of Ireland’s capital markets. While the preliminary nature of such proposals militates against a penetrating assessment of the substantive merits of such proposals, what this paper has sought to demonstrate is that a comprehensive review of corporate governance mechanisms in terms of structure and content is needed before endorsing changes to the current code-based system. The current debate on the need to revisit Ireland’s corporate governance framework has highlighted that there is a hunger for more meaningful engagement with corporate governance issues in Ireland. As regards ‘comply or explain’, that does not necessarily mean having to throw the baby out with the bath water. It can be said that ‘comply or explain’ works well provided that the explanations provided are not formulaic and that the objectives of the approach are not forgotten. The engagement of institutional investors is also critical. It has been suggested in this paper that the issue of moving to mandatory standards raises several issues: the need to evaluate the legacy of ‘comply or explain’ in Ireland, the question of the appropriateness of doing so without fully rationalising what is involved and the need for a co-ordinated approach by regulatory agencies. That being so, the appropriateness of a legislative approach to embed corporate norms should be assessed on a considered basis rather than legislation being a knee-jerk political reaction to unsavoury corporate practices laid bare by the financial crisis. Proposing to alter the systemic balance of a corporate governance framework through the introduction mandatory norms which cannot easily be deviated from should not be undertaken lightly. Furthermore, it is important that what is proposed does not involve using a sledgehammer to crack a nut given that a generic legislative approach may suffer from inflexibility which interferes with the legitimate demands of commerce.